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The Future of Lending to The Underbanked in the Digital Age: Data Driven

  • Richard Freund
  • Jul 17, 2019
  • 4 min read

Updated: Jan 5, 2020

It is no secret that the financial services industry is rapidly changing. We are currently in the midst of a digital age that is engendering prodigious levels of connection and speed in the lending space. For example, customers are now able to apply for loans online and receive a decision in mere minutes. Yet, despite these innovations, there is still a large subset of the population that is excluded from the formal financial system due to stringent regulatory requirements. Individuals from low-income households struggle to obtain loans as they often lack a regular source of income and sufficient physical collateral. However, innovative solutions have emerged, and are still emerging, to address this problem that are beginning to fundamentally change the lending industry.


One of the first organisations to pioneer lending to the poor was Grameen Bank in Bangladesh. Founded by Muhammad Yunus in 1983, Grameen Bank upended conventional banking practices by removing the need for physical collateral and created a banking system for the poor based on mutual trust and accountability. The main factor behind Grameen Bank’s success has been the way that it is organised and managed. Interested people with no assets, or assets not exceeding a prescribed value, form groups of five like-minded people of similar economic standing who enjoy mutual trust and confidence. The group members select a chairperson and a secretary, and, through the chairperson, conduct business with a bank worker at weekly meetings that all members are obliged to attend.


When a group is first formed, it is kept under observation for a month by a bank worker to observe whether the members understand and conform to the rules set by Grameen Bank. When the worker is sure that the members understand the operational aspects of the bank, the group is given formal recognition and is eligible for collateral-free micro-loans. However, not all members are given loans at one time. Initially, only two members are given loans. If they pay their instalments regularly during the observation period of 6–8 weeks, two more members are also given loans. The chairperson is the last person to receive a loan. Members of the group are not eligible for additional loans if any person has not yet paid off their current one. Members thus face considerable pressure from group members when they fail to pay their instalments to the bank, as failure to pay by any member will directly affect the fortunes of the other members. Therefore, the novelty underpinning the Grameen Bank model of lending is that material collateral has been replaced by social collateral[1].


Grameen Bank’s model has proved extremely successful. As of June 2019, Grameen Bank has disbursed over US$27 billion in loans and boasts a recovery rate of over 99% - meaning that over 99% of the loans that it has disbursed have successfully been repaid, with interest. [2] It has thus proved that, if financial resources are made available to the poor at reasonable terms and conditions, they are able to generate productive employment and repay the loan.

Despite its success, Grameen Bank still only operates in Bangladesh. One of the limits to the scalability of its model is that it requires significant personnel to operate. Skilled workers are needed to facilitate successful implementation (e.g. to monitor a group’s adherence and to conduct meetings), and so it is not easily transferrable to multiple destinations (especially to countries where there is a dearth of skilled labour). In order to execute the model effectively, significant investment into technical training and infrastructure may be required.


In light of this, disruptive new ventures are beginning to enter the market and provide innovative, scalable methods of lending to the poor. Fintech has created a new paradigm to the design and implementation of lending strategies for financial inclusion. One company that highlights the potential of fintech to reform the lending industry is Tala - a start-up social enterprise, founded in 2012, that has provided collateral-free microloans to over 2.5 million customers in Kenya, Tanzania, Philippines, and Mexico[3]. Tala is successfully utilising the trend of high smartphone penetration; through its mobile app, anyone with an Android smartphone can apply for a loan with them and receive an instant decision, regardless of their financial history. Unlike traditional financial institutions, that require formal credit histories to lend to customers, Tala uses a mix of alternative data sources to construct a heterodox credit score for its potential customers.


After someone downloads the Tala app and requests a loan, it asks for permission to view key pieces of data on their smartphone. This data includes texts and calls, merchant transactions, GPS locations, social media activity, and the number of people the loan applicants contact on a daily basis[4]. The company then processes all this information in a unique algorithm and decides, in only a few minutes, whether a customer is creditworthy or not. If they are, Tala immediately sends them the money they requested via a mobile wallet.

Tala is fundamentally transforming lending to the underbanked; it is combining behavioural economic insights with cutting-edge fintech software to develop a model that simultaneously does not rely on formal credit history and is easily transferrable to multiple locations. Furthermore, Tala’s unorthodox model is highly effective; their lifetime repayment rate is currently over 90%.


Although Tala is currently only administering micro-loans (its loans average around $50), I believe that it is a harbinger of a lending revolution in the digital age. The Fourth Industrial Revolution is bringing with it unprecedented levels of data, and lending bodies will need to incorporate this into their models to make better-informed creditworthiness decisions. Furthermore, I believe that more and more companies will start to use fintech to evaluate alternative creditworthiness models in their lending decisions. This presents unique opportunities for lending software companies, like TurnKey Lender[5], to facilitate the transition from the ‘old’ lending model to the ‘new’ model.

Fintech has the capacity to revolutionise the future of lending to lower-income consumers in the digital age. Incumbent companies that are currently making their profits from lending to middle- and lower-class consumers cannot afford myopically to keep using the orthodox lending system that relies on formal credit histories. If they do, they stand the risk of - at best - missing out on a large potential market and - at worst - being put out of business by innovative fintech lending ventures like Tala.







 
 
 

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